It's on Friday, and you want to know just how much revenue you're getting from each of your customers. Which sales metric do you go with, crucial for effective sales performance management?
Annual Contract Revenue (ACV) is your best bet.
This is one of the metrics that help you make sense of other sales metrics like customer acquisition cost and customer lifetime value. Unfortunately, most SaaS startups miss out on this opportunity by not giving a crap about ACV.
Let's look at what the ACV is, how you can calculate it, and the bigger picture ACV plays in understanding your overall sales performance.
What is ACV? (Annual Contract Value)
ACV, or annual contract value, measures how much a single customer account generates yearly revenue. In short, ACV shows you how much a single contract is worth.
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Typically, ACV is used by SaaS businesses with a subscription-based model. Most of these businesses bill their customers per year or for periods longer than a year. You can still calculate ACV if you bill customers monthly, quarterly, or semi-annually.
Why is it Important to Know Your ACV?
I've already hinted at it, but ACV is crucial in making sense of your other Saas metrics. In addition to this, ACV helps:
Prioritize Accounts for Reps
With ACV, you get a clear picture of the top-performing accounts. This way, you can better understand which accounts need more attention and a dedicated sales rep. For instance, what would you prioritize if you have an account bringing in $200,000 and another $1,000?
Of course, allocating your best sales reps to the $200,000 account makes more sense. After all, they bring the biggest value to your business. That's not to say you should abandon your other customers. They still need as much attention and care. Otherwise, you risk customers closing the door on you.
Assess Sales Rep Performance
Top-performing reps are great at their jobs. They also bring high-value customers to your company. ACV is a pretty helpful metric for singling out these top performers.
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ACV then becomes a great help in recognizing the best in your team and setting standards for the other reps. Consequently, you'll know how to tweak your training program or develop a better onboarding process for new sales reps. In addition, you can get a clearer picture of the return on investment of your sales team.
That said, ACV should not be the only metric you use to assess the sales rep's performance. You can also use LTV and other key performance indicators (KPIs) to measure the performance of sales representatives.
Dedicate Customer Success Resources to High Revenue Potential Accounts
ACV also helps determine which new customers need Success resources the most. It's easier to pinpoint customers with high revenue potential and the resources that will benefit them.
For instance, you can offer them discounts, premium support, personalized onboarding, custom data migrations, especially managed accounts, and other promotional offers. You can also create more win-win situations by upselling or crossing products to solve more customer challenges.
ACV vs. ARR: What is the Difference?
Yes, the two metrics come close to sounding the same, but they are pretty different. ACV measures the annual revenue from a single contract (customer account).
On the other hand, Annual Recurring Revenue (ARR) shows the revenue for all contracts (all your customer accounts) in a year. ARR is better when looking at the holistic state of your sales revenue in a year. ACV will be useful for seeing how much a single customer brings in a year. You can also calculate the average ACV to understand the average value of a single contract.
Another key difference is that ARR is an industry-standard metric. Most subscription businesses calculate ARR the same way.
When it comes to ACV, most businesses have their own way of doing things. For instance, some companies may include:
- One-time fees such as training and set-up fees
- Expansion revenue from cross-sells and upsells
- Revenue churn
Other SaaS businesses may average the ACV, while others add it to form the total ACV of all contracts. So, it all comes down to the priorities of your company. You can choose to add the one-time fees and expansion revenue or not.
On the other hand, ARR:
- Does not include one-time fees such as set-up or training
- Only considers contracts 12 months or longer
- Do not consider the billing structure ( it doesn't matter whether you use monthly or quarterly billing as long as the contract is for one year or more.)
ARR can accurately forecast your business's revenue since it includes expansion revenue and churn rate. However, ACV always needs to be looked at with other metrics to represent your revenue situation accurately.
How to Calculate Your ACV
ACV calculation for a SaaS subscription business is pretty straightforward. Most revenue tracking tools will have automation to calculate the ACV. But, there's a simple manual formula you can use.=
Here's how to get the ACV the manual way:
- Collect the data of each contract by determining the contract length and the value
- Use this formula to calculate your ACV
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- Do this for every contract (account) to get the total
- If you wish, you can calculate the average by dividing the total ACV by the number of contracts (accounts)
Example: If you have a customer on a 4-year contract where the value of the contract is $48000, your ACV would be:
Total contract value (which you get when multiplying monthly fees with # of months in the contract)/ total number of years in the contract
$48,000 ÷ 4 = $12,000
What if you use an MRR structure where the contract value per month is $300 for 3 years?
Then, you would need to find the value of the contract annually.
$300 x 12 = $3,600
How about when you have multiple customers on different contract timelines?
For instance:
- 1st customer is on a 2-year $4,000 contract
- 2nd customer is on a $3,000 annual contract
- 3rd customer is on a 3-year, $12,000 contract
- 4th customer is on a 5-year, $140,000 contract
1st Customer's ACV would be ($4,000 ÷ 2 = $2,000), the second would be ($3,000 x 1 =$3,000), and the third would be ($12,000 ÷ 3 = $4,000). The fourth would be ($140,000 ÷ 5 =28,000).
The average ACV would therefore be $2,000 + $3,000 + $4,000 + $28,000 = $37,000 ÷ 4= $9,250
On the other hand, the ARR would be $37,000 (the sum of all contract values in a year)
What's a Typical ACV for SaaS Startups?
It might come as a surprise, but there's no ideal ACV. It's different for every SaaS company because too many factors come into play. These factors affect the ACV, such as the type of product sold, whether the company is a B2B or a B2C, and the industry.
Your SaaS startup may have a lower ACV but an off-the-roof revenue. Vice versa is also a possibility.
Consider Netflix, a B2C company. They have an ACV of just $155.88 per customer for their standard subscription. That looks like a pretty low ACV for a giant like Netflix, right? But, when you look at their total revenue, you'll find a mind-blowing $33,723 billion in revenue as of the close of 2023.
As you can tell from this data, a lower ACV does not always signal a small annual revenue. This is especially true if you're targeting many subscribers at a moderate value. However, B2B SaaS companies will usually have higher ACV than B2C companies.
So, should you benchmark ACV data from other SaaS companies in your industry?
Not necessarily. But, if they have a similar pricing strategy to yours, you can. For example, you can compare the ACV if they target high-value clients by setting premium prices as you do. However, the comparison won't make sense if they target a larger customer base with standard subscription pricing.
Context Matters: Making Sense of Your ACV
I'm sure you can tell ACV is a valuable metric so far. But, you can't use ACV alone to make sense of your sales revenue. You have to recruit other metrics to make accurate predictions and informed decisions.
Below, we explore how you can use ACV in the right context with the help of other metrics.
ACV and CAC
These combinations offer the best value for ACV. By tracking both annual contract value and customer acquisition cost, you can quickly determine how long it will take to recoup your customer acquisition investment. If the ACV is lower or insufficient to offset your CAC, an issue needs correction.
ACV and ARR
This is another metric match that can benefit businesses. You can track ARR and ACV to understand the average contract value and the number of customer contracts you need to reach your ARR goals.
ACV and LTV
You can use both metrics to determine how much value a single contract brings in the long term.
If you want more clarity on each customer's value to your business, you can't go wrong with ACV. It's just a matter of using the ACV metric within the right context and in conjunction with other metrics.
ACV and TCV
TCV (total contract value) tells you the total value of a customer over the lifetime of their contract. Comparing ACV and TCV can be useful when deciding where to leverage resources. For example, a very high ACV customer might have a low TCV if they churn.
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How to Use ACV to Grow Your Revenue
Using ACV, you can:
- Prioritize the right accounts
- Assess how your reps are performing with big deals
- Dedicate the right resources to the deals that matter most
- Make smarter business decisions
When you do this, you'll work more intelligently to build a better foundation for your business and be able to track how your customers add value over time.
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